Labor Economics Fraud from White House Economists

White House economists have a simple trick for projecting wonderful labor market results from just about any policy they like:

• Take the market-expanding effects and put them through a multiplier machine, such as a Philips curve analysis.
• Take the market-contracting effects and put them through a shrinkage machine, such as a labor supply and demand analysis with labor supply assumed to be fully wage inelastic.
• Add the results together, which amounts to ignored the market-contracting effects, while advertising that you considered all of the effects.

The honest way to do this would be to take all of the effects and put them through the same machine. We can debate whether it should be a multiplier machine or a shrinking machine, but at least the direction would be clear.

Here’s and example: the White House’s the Economic Case for Health Reform. Take a look at page 30, where they look at potentially market-expanding effect: a reducing in health care costs. It’s fundamentally a labor market tax effect effect (in the direction of cutting the tax rate) because (in their view) cutting employer costs will not commensurately reduce employee value of compensation: see also page 612 of this paper.

They say that this effectively-tax-cut will reduce inflation and, through a Phillips curve analysis, reduce unemployment. It’s not the way I would approach it, but that’s not fraud. The fraud becomes visible on page 36 where they note that parts of health reform raise marginal tax rates.

Unlike the tax cut effect of health care cost reductions, the White House economists put the marginal tax rate hike analysis through a labor supply and demand analysis in which labor supply is wage inelastic. Therefore, the marginal tax rate hike has essentially no effect on the quantity of labor.

Again, that’s not the way I’d approach it, but that’s not the fraud. The fraud is saying that marginal tax rate hikes have zero effect while at the same time saying that marginal tax rate cuts have big effects. Choose one machine — a multiplier machine or a shrinkage machine — and use it consistently.

In this case, their simultaneous and inconsistent use of multiplier and shrinkage machines distorts their final conclusion in exactly the wrong direction.